Why the whole world is watching to see what Commissioner Kenneth Hayne does next

Justin O'Brien

Dec 6, 2018 — 11.00pm

As the global financial crisis demonstrated, the tentacles of the finance industry traverse state boundaries. They create moral and economic hazards as well as opportunities. Each poses legitimacy and authority implications. Failure to address those threats have contributed to a populist turn which, in turn, runs the risk of further policy uncertainty and instability.

Hayne offers an unrivalled opportunity by providing a normative foundation still at formative stages in the international agenda. That agenda has been ignored in the domestic hearings and background papers, largely as a consequence of timing restraints. This myopia has been to the detriment to both the inquiry and the international reform agenda. Paradoxically Hayne now has a unique opportunity to reset the parameters of corporate governance, culture and conduct by providing a coherent, cohesive framework that builds accountability, embeds restraint and restores trust.

Can Commissioner Kenneth Hayne find a way of linking resilience to purpose? David Rowe

Doing so requires the integration of rules, principles and social norms within a governance framework with global applicability. It is an essential and urgent task. While building a resilient infrastructure is essential, this has to comprise values as well as utility. Responding to this crisis through resilience as both metaphor and organising framework is, however, problematic.

Privileging resilience as an end in itself may prove counter-productive unless underpinned by a normative reset of the purpose of the corporation and the market and duties and responsibilities each owe to society. This is what Hayne is suggesting with his six normative principles. This is precisely what has been ignored. Paris provides evidence of the current model's unsustainability.

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Inside the beehive

The normative and practical value of resilience can be likened to the circumambulation of a beehive, where service, industry, preservation and order integrate to achieve social harmony. In structure, purpose and functioning the hive is the antithesis of uncertainty. It is a compelling metaphor in an age of anxiety and distraction.

Unlike the hive, in the human social world common purpose, duty and obligation are weak and weakening. While the neoliberal market consensus may have broken down, libertarian impulses informed by misguided faith that preservation of self-interest will safeguard stability remain stubbornly resilient.

Governance through self-interest alone guarantees disloyalty and chaos, characteristics recognised by both Adam Smith and Jean Jacques Rousseau. Informed by an existential crisis, the contemporary liberal order faces profound questioning of the capacity of democratic institutions to resolve intractable problems across multiple domains.

The idea of resilience is replacing sustainability as both the means and the end of an increasingly cross-pollinated academic and policy discourse. On one level, this is unsurprising. Resilience suggests strength and capacity to adapt. It implies that, with more capacity to identify and neutralise threats in advance, well-being can be protected at individual and societal levels. As such, it offers a beguiling trifecta: diagnostic tool; palliative treatment; and ongoing sentinel protection that span temporal and spatial horizons.

The outgoing chair of the Financial Stability Board, Mark Carney, is less sanguine about a world in transition. He warned about the danger of complacency and the need for vigilance, particularly in non-bank finance and asset management, operational risk, and the potential "issues crypto assets pose around consumer and investor protection, money laundering and terrorist financing".

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As Carney concluded wistfully in his final report as chair of the FSB, "800 years of economic history teaches that as memories fade, complacency sets in, and backsliding begins. In financial stability, success is an orphan. The G20 and FSB bear heavy responsibilities to safeguard recent progress, address new risks, and seize new opportunities presented by the major transitions underway in the global economy and financial system."

All of this would appear to be news to those following the royal commission that wrapped up in Melbourne last week.

It was an extraordinary final two weeks in which regulators and chief executives were subject to direct, incisive questions that they were unable or unwilling to answer. It was a blamefest of epic proportions. Everybody blamed everybody but no one was left holding the baby. Not only did they absolve themselves of accountability to promises made but, we were told, these were not legally binding anyway.

In a defence used time and time again internationally, we were told we are dealing with legacy issues associated with previous leadership teams. In the case of the CBA, these were conveniently thrown under the bus by current CEO Matt Comyn, who was responsible for the retail division where the misconduct occurred, although not responsible for the design of the product it sold.

Catherine Livingstone, the chair who appointed him and defended the promotion, stated bluntly that it would be impossible to find anyone globally untainted. Even more startling was her defence of her actions as a non-executive director. She claimed she raised questions but was forced to admit no record of this dissension existed. Instead she wished to look forward. Not so fast. As an experienced non-executive director, she admitted it took months to read in and the training was inadequate. For the largest corporation by market capitalisation, this is nothing short of a disgrace.

All of the warnings pointed out by Neville Owen in the HIH royal commission in 2003 to corporate boards and supervisory agencies alike appear to have been ignored. Institutions privileged technical compliance process over substance and short-term profiteering over long-term interests of the corporation and the society in which it is nested. It was all, we were told, an honest mistake.

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As to why, the answer was given by the NAB chief executive Andrew Thorburn. Under sustained questioning he could not mount a credible defence of its culture because NAB itself did not understand its own purpose. He attempted to assure counsel assisting that in addressing that core question now, things will be different in the future.

NAB chairman Ken Henry went further, suggesting that it would take at least 10 years to turn the culture around if not longer. The only short-term fix, he dismissively and contemptuously suggested, was "to fire the lot of them".

The hubris and disrespect with which the industry has treated this inquiry has been treated, and by extension the people of Australia, is a national calamity. If the financial sector cannot determine its purpose, then that purpose will be defined for it. The only question is whether it will be through the ballot box, on the streets or in a courtroom.

This time is different: The dystopia of the information age

The trust deficits manifest themselves at personal, social, institutional, and increasingly virtual levels, where social restraint on online platforms has all but disappeared. This is why the situation facing the corporate sector as a whole is so problematic and why Hayne's final report could be so transformative.

Relative resilience is inextricably linked to our conception of the trustworthiness of the information and reassurances provided before, during and in the aftermath of a crisis. In summary, it depends on the trustworthiness of institutions, private and public, to live up to their promises.

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Disasters with even larger impact than natural ones occur through direct human action within and between political and socio-economic spheres. Disruption in one specific domain can prompt contagion. The metastasis occurs most notably, virulently, and most regularly in finance. Policy calibration to address it at national or international level can, however, produce unintended consequences.

Rhetoric alone, even if soaring, cannot compete against the rise of precariousness, as recent riots in Paris coinciding with the G20 meeting in Buenos Aires so graphically demonstrated. The vagueness of the G20 communique contrasted sharply with direct repudiation of a rise in fuel taxes to encompass a generic sense of grievance in which the richest areas of Paris were targeted for vengeful destruction in the worst riots seen in a western European capital since the imposition of a local council tax in London in 1989. Surveys suggest that, despite the government blaming the violence in far-left and far-right infiltration, the majority of French population support the amorphous movement's aims.

Not surprisingly, both the call to arms and the targeted rioting is organised through both open platforms and encrypted messaging. As with the Arab Spring, we are in an era of the digitally organised riot. Hope can be undermined. It is impossible to construct a compelling narrative in the face of deepening chaos and resentment.

In such circumstances, people can come to believe the political and corporate elite have accepted the socialisation of losses and privatisation of profit. The lexicological shift from risk to resilience is, therefore, not without potential political calculation. On one level, it suggests that lessons have been learnt and that multilateral policy intervention does take into account the interests of the most vulnerable. Resilience in this sense, like calculation itself, can exude a negative connotation. It can privilege the illusion of fundamental change while leaving undisturbed the fundamental causes.

The critical point is that resilience is not in and of it itself a neutral term. Adaptive capacity may mask significant and ongoing imbalances. These, in turn, may exacerbate the trust deficit.

This is particularly the case in finance. The flawed governance and remuneration policies along with cultural failings within the finance sector, unanchored from the societies in which they operated, proved incapable of meaningful accountability. The prosecutorial decisions of cowed and under-resourced regulators, which opted for settlements and financial penalties over admissions of guilt and criminal prosecutions, did much to further undermine confidence. Rebuilding the very system that allowed this to happen would turn tragedy into farce.

What is to be done

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Two unresolved sets of questions remain from the 2007-2008 global financial crisis and its aftermath. The first focuses on whether and which interests were privileged and at what cost? What sanctions were available to force compliance? Were they used and, if so, were they an effective deterrent? This raises the question of a system's capacity or willingness to adapt when ideational assumptions are undermined, if not altogether falsified. This fragmentation was evidenced in the fractured relationships within and between the International Monetary Fund, European Commission and European Central Bank troika in the management of the Greek and Irish economies. Following extensive bailouts, invasive conditionality clauses were inserted (and variably implemented). The imposition generated an existential crisis for both debtor nations and creditor institutions.

The second set of questions, from a socio-economic and political context, is more important. Why is finance as an industry so susceptible to outbreaks of white-collar crime? Crime is crime. Breaking the law is breaking the law, even if justice, or its approximation, is dispensed in the civil rather than criminal court. Even then infractions do not include admissions of guilt but are subject primarily, through choice, to acceptance of extra-judicial contracts.

Criminology literature has long debunked the critical drivers as being individual disposition, greed and non-commitment to commonly-held values alone. What then is it that makes the corporate environment, particularly in banking and financial services, so susceptible to criminogenic tendencies? The manipulation of the London Inter-Bank Offered Rate (LIBOR) and its global facsimiles are a case in point. The conduct within trading-room sub-cultures was systemic. The downward spiral it facilitates can and does move from self-righteousness and self-pity to delusion. It is remarkable that one of the defences offered by the UBS trader Tom Hayes to his manipulation of the yen-Libor financial benchmark was that, while it may be deemed dishonest by the general public, it would have been seen as acceptable practice within the trading network he worked within. Not surprisingly, this was rejected by the initial court and at appeal.

Understanding these causes and integrating that knowledge in the search for solutions to strengthen institutions is essential. This need has been demonstrated in empirical research undertaken by the OECD, which suggests that fragility is correlated to the relative strength of financial services vis-à-vis countervailing institutional power. It also highlights the importance of articulating and being held to account to a defined purposive. Without it, a focus on undefined resilience becomes dangerous. It risks embedding the very cultures, governance and remuneration that can prove so calamitous to wider society.

The theoretical connection between resilience and sustainability, while often made, is neither necessarily empirically true nor a good thing in itself. Within the liberal order, where the existential crisis is most pronounced, there is an ongoing need to balance rights, duties and responsibilities through an admixture of rules, principles, and social norms.

Reciprocity and other-regarding social norms – not self-interest – form the core of any genuine social contract underpinning a functioning democracy. Sustainability necessitates an equal balancing of equality of opportunity and liberty. These foundational principles do not necessarily act in unison. The social contract is based on principles of fairness and justice but to remain vibrant requires vigilance to protect the general will against forms of manipulation and self-interest, which, left unattended, can lead inexorably and inevitably to a dystopia of alienation, oppression and unfreedom. These principles require the integration of technical and normative dimensions, which, if necessary must be adjudicated by the courts. All of this is at the core of Hayne's proposed repositioning.

The lack of judicial precedent in the governance and oversight of the financial sector helped create the normative vacuum that led to the GFC. Moving from price as a proxy for efficiency to effectiveness requires a critical – but to date untaken – critical step. While it may not be possible to legislate for ethics, it is possible to legislate for breach of promises entered into by virtue of voluntary commitment to legally-binding promises. It is essential, therefore, when designing systems of oversight that these promises are specified.

Metrics must be developed to test relative effectiveness of those promises, with the results (and regulatory responses to them) made public. While considerable work has been undertaken to date to build capital buffers, the work on culture, governance and remuneration, critical drivers of behaviour has only just begun at an international level and here solely with toolkits for participants and regulators with regards to the wholesale market.

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The overt comparison of a social-system to an eco-system, allied to evaluation within the context of adaptation, is part of the allure. The essential ambiguity of the very term 'resilience' is both a source of attraction and distraction. It requires the analyst to be sensitive not only to the physical landscape but how that space is simultaneously patrolled and used as hunting ground. It does not, however, invalidate the concept. Abstraction is in and of itself not antithetical to effective public policy.

Abstraction provides a theoretical but essential foundational core. Thus, for the British philosopher Derek Parfit, an act is moral if it is "universally willable, socially optimific and not unreasonably objected to". This chimes with the core normative foundations set out in Hayne's interim report. If embedded with sufficient cultural sensitivity and nuance, Hayne's suggestion can speak to and attract support irrespective of geographic locale or level of educational attainment. With appropriate empirical testing, the bridging of norms and reality as mediated by political and corporate realities can occur. If not, disaster beckons.

Sustainable resilience necessitates we absorb, communicate, recover, regroup, adapt and, most importantly, learn. None of this is to suggest that it is possible or even desirable to have a zero-tolerance towards risk. What is essential, however, is that the parameters of that risk are mapped and disclosed in order to secure genuine informed consent. Such an approach builds consensus, reduces fear and anxiety. This consent is essential in maintaining trust.

Politics, like nature, abhors a vacuum. Seen in this context, resilience of a given system is not simply a technical issue. It is a critical normative foundation. Weaknesses can breed resentment, not least when accompanied by inability to explain how and why a particular crisis emerged and what can or should be done about it, including the capacity of the judicial system to hold those responsible to account. These failures have contributed enormously to the collapse of confidence in institutions – business, government, media, and non-government organisation sector – most notably across the liberal order.

In the absence of respect, legitimacy and authority, all institutions face the threat of the demagogue. When trust is eroded, sloganeering becomes an effective rallying call to unite the discontented, which is precisely why the trust deficit is so problematic in stable democracies.

The spectacular rise and fall from grace of globalism and globalisation is paradigmatic. All economic, social and political decisions necessarily involve trade-offs. These inevitably privilege short-term criteria. They also leave systems vulnerable to sudden catastrophic failures or with the incapacity to address them. Nowhere is this more so than in the challenges posed by and to the transnational corporation.

Enhancing the resilience of the G20/OECD Principles of Corporate Governance, through the normative principles enunciated by Hayne, therefore may have a cascading effect.

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The OECD secretary-general Angel Garcia has noted "the purpose of corporate governance is to help build an environment of trust, transparency and accountability necessary for fostering long-term investment, financial stability and business integrity, thereby supporting stronger growth and more inclusive societies". The principles, therefore, are not an end in themselves, but the framework on which to "develop more detailed mandatory or voluntary provisions that can take into account country-specific economic, legal and cultural differences".

The simplest way of achieving this is to make the normative principles in the interim report a condition of holding an Australian Financial Services Licence. Everything else flows from that premise. It turns Parfit's abstraction into a reality that can be tested and trust warranted.